Millionaire MBA Day 17: Leverage
by
Millionaire MBA
SMASHWORDS EDITION
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Copyright © Millionaire MBA 2011
First Published 2011 by ELW Publishing Bath, UK
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Contents
Introduction
A few years back, 50 leading UK entrepreneurs and business owners were interviewed in their homes, offices and hotels. The purpose of the interviews was to find out exactly what made them successful, and how other aspiring entrepreneurs could replicate their business success.
Those digitally recorded audio interviews were turned into a 'timeless' business mentoring programme called Millionaire MBA. Millionaire MBA is regarded as one of the best programmes in the world to teach entrepreneurial thinking and the 'millionaire mindset'.
Millionaire MBA is a rich, deep mentoring programme which existing and aspiring entrepreneurs listen to over 40 days. Literally tens of thousands of entrepreneurs (like you) around the world have benefited from this programme.
In this ebook, you’ll find the actual transcription from one whole day of the mentoring programme.
To find out more about the full business mentoring programme or to listen to the audio version, please visit http://www.millionairemba.com/
Day 17: Leverage
Welcome to Day 17, "Leverage."
Around 300 B.C., Archimedes said, "Give me a lever long enough and a prop strong enough, and I can single-handedly move the world." Archimedes was, of course, talking here about the power of leverage.
Leverage is the tool of choice for entrepreneurs who want to get the maximum output from the minimum input.
It's also the secret weapon of choice for those who want to move beyond the self-employed stage to creating a sizable business which they work on, rather than in.
The principle of leverage uses resources such as money, time, ideas and people to our advantage.
Leverage can also include the use of assets, such as networks, technology, information, equipment and brand. By ourselves, we have limited reach, but by combining the power of these other resources, we can achieve the seemingly unachievable.
We'll examine each of these types of leverage over the next 30 minutes, but let's start by exploring the most familiar form, financial leverage.
The best way to explain the concept of leverage is with a simple example. For this, I'll use a very familiar, non-business concept of buying a house with a mortgage.
Let's assume that you purchase a house which costs £100,000 and that you put down a deposit of 10 percent or £10,000. Let's assume, also, that over the course of one year, the house is appreciated by £45,000.
When you look at the sums here, for your £10,000 of equity invested, you've actually created a £45,000 profit or a return on equity of 450 percent.
Clearly, the return on the overall investment of £100,000 is only 45 percent, but what really matters is the return on your original equity investment of £10,000.
This colossal return of 450 percent is only possible by leveraging your initial £10,000 with £90,000 of bank borrowings or other people's money. This is the power of leverage.
Let's start today by listening to Duncan Bannatyne as he shares his insights into financial leverage.
Duncan Bannatyne
The only leverage I've used is bank borrowing. I often have conversations with businessmen who are different.
So many people in certain businesses say, in certain public companies, "You should never own a freehold. You should only rent your premises."
And I work out all the scenarios, and let's say, if you rent it and it only costs you £1 million to fill it out, you get less return, but I say it costs me £4 million, but I only actually put £1 million because I borrow £3 million.
So I'm only investing £1 million and I work out the terms are better, but they just can't seem to see it that way.
Perhaps they're not very good at borrowing money, and perhaps that's why they'd prefer rentals, but when you can borrow money, and I think I owe the banks...
My companies owe the banks about £75 million at the moment, and I'm paying 6 percent interest on that £75 million, and I'm making about 20 percent return on average, so that leverage has given me fantastic amounts of profit.
Fourteen percent of the £75 million is from money that I don't own, after interest, so it's terrific.
Duncan's advice is therefore to borrow. Remember though, these types of borrowings are smart borrowings which can be used to create a higher return.
Every penny that Duncan borrows is used to create more money.
It's essential to understand the difference between borrowing to pay for a new car or holiday or any other expense that creates a negative return or negative cash flow, and borrowings that will create a future positive return and positive cash flow.
It's the difference between thinking of debt with the employee mindset and thinking of debt with the millionaire mindset.
Listen again as Duncan explains more on borrowing and leverage.
Duncan Bannatyne
Borrow, borrow more, borrow more. As long as you're getting a return, you don't borrow stupidly and think...
When I started the first nursing home - I don't know if you know this, if you've read through my past - I had the ice cream business, and I had to build a nursing home, and I didn't have enough money to build it.
It cost 350 to build, and it was worth 650 when it was sold, and I had to pay the builder every month, and when I started out, I didn't have the money.
I actually got three credit cards, and this is obviously a situation of taking advantage of what's out there at the time.
Credit card companies were falling over themselves to give you a credit card that you could borrow £10,000 on.
So I got a credit card, borrowed £10,000. I got three, so I borrowed £30,000, and I used that to pay the fifth month of the building programme. That was big leverage and big risk, but I knew it was going to work.
Financial leverage is therefore the most obvious form of leverage.
Listen to the next few entrepreneurs as they talk about the various aspects of this subject and the use of OPM or other people's money.
Stephen Streater
The other people's money tends to something else; [what I was] taught when I was a student is never use your own money because you'll make lots of mistakes.
In fact, my first venture capitalist who helped me set up Eidos said that all businesses failed three times before they made any money, and the process of venture capital consisted of transferring the venture capitalist's money directly into the executive's experience.
We were fortunate at Eidos that the three times we ran out of money, we didn't actually go bust.
We managed each time to raise money in the City at high prices, so we had our three lives. Normally you'd get dilution and you'd end up with nothing, but other people's money is very important.
The other reason it's important is because other people won't put their money in unless they think it's going to work.
So, it's this accountability thing, that however confident you are, if there is some gap in your logic or in your plan, people won't put money in, and then you can say, "Well, if people aren't putting money in, there must be a problem," and you can go and fix it.
Whereas if you do it all yourself, you've got no one to say,
"You're not doing it the right way," and, of course, we're a quoted company, and that's very good because you can do things, and people either like it or they don't, and if they don't like it, you know, because the share price goes down, and if you do something they like, you know, because the price goes up.
That's rather simplistic, but it means you know, it's accountability.
If it's other people's money, they've got no reason to give it to you or to buy your shares except to make money, and they will only do it if they feel they're going to make money out of it.
Luke Johnson
Well, leverage has many meanings. I normally use it in the context of financial leverage, i.e. debt.
In these current times of low interest with 3.5 percent base rates, 50-year lows, getting some debt into a deal is pretty important because it's cheap money.
Obviously you have to pay it back and you have to pay interest, but also you don't give away any equity.
So I like deals that do have some debt in, and one of the issues one always faces with start-ups is it's very difficult to get banks to lend, and that's a challenge when debt is the cheapest form of funding by far.
Sir Christopher Evans
I've always done that, leverage in terms of... I use other people's money. I use my own money. I use people's equity money, people who take a stake in something at full risk alongside me.
We use banks. We use debt finance, and we structure things. We've lots of different parties, different stake holders.